HINDMAN — A sharp drop in Eastern Kentucky coal production has created million-dollar budget shortfalls that could bring layoffs and tax increases to some coal counties.

A bulldozer moved coal at a processing tower at an Arch Minerals facility in Knott County on Wednesday. The company closed the underground mine at the site, but still uses a coal-processing facility and a tipple to load rail cars.

HINDMAN — A sharp drop in Eastern Kentucky coal production has created million-dollar budget shortfalls that could bring layoffs and tax increases to some coal counties.

In Knott County, the fiscal court appointed a committee last week to recommend ways to deal with a projected shortfall of $1.2 million in budgeted coal severance tax receipts.

"You can't pay your bills at this point," Andrew Hartley, staff attorney for the state Department for Local Government, told officials at the fiscal court meeting.

In neighboring Letcher County, the fiscal court has cut overtime and is trying to hold spending to essential purchases as it deals with a $1 million shortfall in coal taxes, the county treasurer said.

Those counties are not alone in their efforts to adjust to declining coal severance taxes, which coal-producing counties commonly use to buy equipment and fund a variety of programs, from roadwork to senior citizens centers and fire protection.

"They're all facing the same dilemma, some more than others," said Richard Tanner, executive director of the Kentucky Coal County Coalition.

Floyd County, for instance, will likely receive $1.1 million less from the severance tax than budgeted. Perry County will likely get about $1 million less than budgeted, according to an estimate last week by the Department for Local Government.

Statewide, coal tax receipts fell 19 percent in the final quarter of fiscal year 2012 — April, May and June — and then an additional 19.1 percent in the next three months, according to the Governor's Office for Economic Analysis.

The severance tax is a levy Kentucky collects on the production and processing of minerals, most notably coal, and on natural gas. The state keeps much of the money, but more than half of Kentucky's counties get a share as well, either because they have mineral production or are impacted by it.

The amount that goes to coal-producing counties is based in part on the amount of coal that companies mine there. That's why several are facing shortfalls.

In the 10 Eastern Kentucky counties that produced the most coal in 2011, production in 2012 was down a total of 28.9 percent, according to information provided by the state Department for Energy Development and Independence, using federal production data. The drop was steeper in some counties — 46 percent in Martin County, 45 percent in Knott and 36 percent in Letcher.

In contrast, coal production in 2012 went up in several Western Kentucky counties. Those counties once faced a disadvantage because the coal there has a higher sulfur content, but the installation of scrubbers at power plants to cut down harmful emissions revitalized the market for coal from the area.

The coal industry and many local officials in Eastern Kentucky blame federal environmental regulations on mining and burning coal for the drop in production there. Industry analysts, however, say other factors — competition from cheap natural gas and Western U.S. coal and a relatively high mining cost in Eastern Kentucky — have had a more immediate impact on production.

Steep declines are expected to continue in coming years. In a report released last June, the U.S. Energy Information Administration projected that annual coal production in the region that includes Eastern Kentucky would drop from the 2010 level of 186 million short tons to 132 tons in 2015, and to 92 million tonsin 2018 — a decline of more than half in less than a decade.

The Governor's Office for Economic Analysis said in a report last October that the coal severance tax is expected to "continue its recent and pronounced negative trend."

Coal companies laid off an estimated 2,000 miners in Eastern Kentucky last year, so the decline has hurt families, companies and the economy, in addition to county budgets.

The drop in coal tax revenue has hit Knott County harder than many others because it relies on the tax for a relatively large piece of its budget.

Its tax on real property, for example, brings in far less than coal severance. A $56,000 house in the county with a homestead exemption would have generated $178 in property tax last year, of which the county government would receive $26. The same house in Fayette County would generate $216, or 21 percent more.

The county likely needs a combination of higher taxes and cuts in employees or services to balance its budget, according to state officials. The county would be left with a "skeleton government" if it tried to eliminate the deficit with cuts alone, according to the Department for Local Government.

"You can't tax your way out of it and you can't cut yourself completely out of it," DLG Commissioner Tony Wilder told local officials.

Hartley outlined the county's options for increasing tax revenue through an occupational tax, a levy on business profits or an insurance-premium tax, though Hartley noted the last one would not bring in any money in the current fiscal year.

Deputy Judge-Executive Greg Mullins said the county laid off people and made other cuts last year to balance its budget, but needs to move quickly on additional measures to deal with the current shortfall.

"Every day we wait is a day we're going deeper," Mullins said.

The fiscal court has rejected an occupational tax in the past.

Discussion of tax increases at last week's meeting didn't sit well with some residents. Roy Jent, a retiree who lives in the Littcarr community, spoke against any new taxes.

Jent said county leaders, in particular Judge-Executive Randy Thompson, who went to federal prison in December on a vote-buying conviction, committed the county to excessive spending.

He pointed to the Sportsplex, a large recreational facility, as an example of a program that doesn't pay for itself. The county uses coal-severance money to subsidize the facility.

"Now they want to raise taxes on us, but we've got nothing down here to tax," Jent said. "You pass an occupational license tax on everyone working in this county and you won't raise enough money to make a payment on the Sportsplex. There just aren't that many jobs."

Other counties hope to survive declining coal tax revenue without layoffs and tax increases, at least in the short term.

In Harlan County, Judge-Executive Joe Grieshop said the county is looking at ways to increase revenue from the jail and has taken other cost-cutting measures, such as reducing contract workers, Grieshop said.

"We just have to adjust down," Grieshop said.

The decline is manageable because the fiscal court budgeted cautiously, he said.

Bell County Judge-Executive Albey Brock said he and magistrates anticipated a decline in coal money and will be able to absorb the projected $400,000 shortfall without major problems.

Brock said the decline in coal tax revenue will force the state to consider changes, such as altering how the money is divvied up in order to give counties a greater share, or increasing the tax rate.

State Rep. Fitz Steele, a Democrat who represents Perry County and part of Harlan County, has filed a bill that would give all coal-severance funds back to coal-producing counties.

Similar proposals have failed in past legislative sessions because lawmakers were reluctant to give up the state's share of the money. Floyd County Judge-Executive R.D. "Doc" Marshall expects a similar outcome this year.

"I don't think that will fly, but I pray that it would," Marshall said. "If we produce it, we ought to get to keep it."